Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

16.3 Job-Order Costing

Intended learning outcomes: Describe actual quantities and actual costs. Explain cost analysis. Produce an overview on the interface from order management to cost accounting.

16.3.1 Actual Quantities and Actual Costs

The actual quantities are the quantities of components and capacity used for an order.

The shop floor data collection system (see Section 15.3) provides the data on the actual quantities for a production, procurement, or R&D order. The actual quantities are generally used as a factor in calculating actual costs:

The actual order costs are the costs generated by an order.

In simple cases, we can determine the actual order costs as follows:

Backflush costing is the application of costs based on the output of a process. It works backward to flush out the costs for the units produced, applying costs using standard costs. Backflush costing is usually associated with repetitive manufacturing environments.

In all other cases, we determine actual order costs by an accumulation of job-order costs according to the following cost identification techniques:

  • Standard costing or standard cost (accounting) system: actual (used or consumed) quantities times standard cost rates for variable and fixed costs.
  • Normal costing or normal cost system: invoiced amounts or actual cost of wages for variable costs, actual (used or consumed) quantities times standard cost rates for fixed costs.
  • Actual costing or actual cost system: invoiced amounts or actual cost of wages for variable and fixed costs.

We thus obtain a total for each of the individual cost types in corre­spondence to the cost accumulation breakdown shown in Figure The algorithm for job-order costing corresponds to the procedure illustrated in Figure Here, the data are taken from the business object order, rather than from the master data (see Section 17.1 for further details). In the costing method shown in Figure, the actual values are entered into the columns on an ongoing basis (ongoing job-order cost accumulation). The values listed correspond to usage by the reported operations and the parts issued. In this way, we can continuously track the costs of every production order and compare them against the target values. Continuous comparison is particularly important for production according to customer orders, since these are subject to a budget. This will identify the likely profit or loss at a relatively early stage, enabling us to take corrective action in good time.

For the comparison to be meaningful, the cost identification techniques used for cost estimating and job-order costing must be the same. However, for some types of costs, this may not be the case:

  • For actual costing, the invoices for materials or external operations may arrive much too late for efficient control of internal operations. If this is the case, we can then fall back on the standard load or the actual quantities valued at standard cost rates.
  • Global invoicing may sometimes make it difficult to assign costs fairly to individual resources obtained externally, which means that standard cost rates may prove to be just as accurate. These standard cost rates are again multiplied by the actual quantities.
  • The valuation of material costs on the basis of standard cost rates may be inaccurate due to large fluctuations in the cost of purchased items. Under these circumstances it may be necessary to use the average costs as a basis or to value certain materials at the actual cost of the procurement batches.

If actual costing is chosen as the cost identification technique, then the estimated-cost accumulation essentially reflects the most recent order. We may, however, impose a budget on the individual cost types that does not necessarily correspond to the total standard costs for the underlying operations or individual items issued. If the budgets correspond to the expected revenue, then the ongoing comparison of estimated cost (budget) against job-order cost accumulation leads directly to the expected revenue from the order.

16.3.2 Cost Analysis

Cost analysis seeks to reveal significant variances (i.e., variances that exceed established thresholds) of actual costs of an order (theactual order costs) from target costs.

Volume variances occur when the resources consumed deviate in quantity from planned quantities.

There are various causes for volume variances:

  • Volume variances in an internal operation. Here, the actual load differs from the standard load because:
    • Unanticipated incidents occur during production.
    • The work center efficiency or efficiency rate (in a time period) is better or worse than expected.
    • The specified quantity of standard capacity requirement is wrong, or the quantity consumed is recorded incorrectly.
    • Additional operations are needed for reworking.
  • Volume variances for a component or an external operation. The quantities consumed differ from the quantities specified on the bill of material or route sheet, because:
    • The wrong standards (estimates) were used.
    • Goods are lost or scrapped.
  • Variances in the costs per unit produced. If scrap is produced, the quantity actually produced may be less than the quantity ordered, in which case the cost of goods manufactured per unit produced will be higher than expected, because most of the components and resources were used for the initial operations in accordance with the original quantity ordered.

Standard costing reveals all these variances through a simple comparison of the job-order cost against the estimated cost accumulation. Since the underlying cost rates remain the same, the job-order cost accumulation highlights any volume variances.

Cost variances are deviations between actual and standard costs.

Cost accounting analyzes the various cost variances, namely:

  • Variances between the actual costs of the purchased components and the standard costs for the same items.
  • Variances of the actual costs of a capacity unit of a work center. The costs per capacity unit are predicted for the future based on past values in the form of a forecast. At the end of the budget period, this reveals variances arising from undercapacity or over­capacity, meaning that fixed costs should actually have been divided by a different load.

When basing costing on the actual costs, comparison of job-order and estimated-cost accumulations yields variances that encompass both volume and cost variances. To show these variances separately, we must add a third column that captures “actual quantities at standard cost rates.” However, we can only do this if we know the cost rates when we carry out the estimated-cost accumulation. But, if we specify only the total budget for each cost type, then we cannot show volume variances separately from cost variances.

16.2.3 The Interface from Order Management to Cost Accounting

Carried out in the context of production order management, cost object accounting, e.g., product costing or project costing, is in essence job-order costing as described above. 

Cost accounting also performs cost object accounting. Other outputs from cost accounting are cost center accounting and cost object group accounting. To be accurate, all costing systems, in particular, costing software, require a regular input of production order data and shop floor data. These data-capturing systems provide the interface to the cost accounting system and allow accumulation of the necessary cost data.

Costing software also manages the value of work in process. The cost accounting department requires a report of every transaction associated with a production order. These transactions include:

  • Release or amendment of a production order.
  • Every stock issue. Each stock issue increases the value of the work-in-process and reduces the value of inventory by the actual costs.
  • Every execution of an operation. The actual cost of the operation is added to the value of the work-in-process. The load on the corresponding work center is reduced.
  • Every invoice for delivery of goods or external subcontracting of work. We can also allocate the costs to a dummy inventory account or cost center, rather than the work-in-process, which will then be unloaded by a corresponding issue at standard cost rates.
  • Completion of the order. The accumulated value for work-in-process for the order, together with the fixed costs, is charged either to the inventory account or directly to the expense account for customer production orders.

Transactions can be carried over every day. If cost accounting is carried out on a monthly basis, however, the data are transferred immediately before the accounting starts.

Note: At the end of every accounting period — at month’s end, for example — all the actual values (such as the quantity consumed or actual costs) must be stored temporarily in a “quantity consumed to end of accounting period” attribute. This can be accomplished by a program that is run at the end of each accounting period. In this way, when the cost accounting department receives the data on the fifth of the month, for example, it receives the values stored in the temporary attributes. This is because the actual “quantity consumed” attri­bute now contains the usage that has accumulated in the new accounting period.

Course sections and their intended learning outcomes

  • Course 16 – Cost Estimating, Job-Order Costing, and Activity-Based Costing

    Intended learning outcomes: Produce a review on costs, cost elements, and cost structures. Explain cost estimating in detail. Describe job-order costing. Disclose activity-based costing.

  • 16.1 Costs, Cost Elements, and Cost Structures

    Intended learning outcomes: Produce an overview on actual, direct, and overhead costs. Differentiate between average costs and standard costs as well as between variable costs and fixed costs. Explain the cost accumulation breakdown that is the cost breakdown structure of a product.

  • 16.2 Cost Estimating

    Intended learning outcomes: Present an algorithm for cost estimation of goods manufactured. Produce a representation of the cost accumulation and an overview of the comprehensive calculation for a product line.

  • 16.3 Job-Order Costing

    Intended learning outcomes: Describe actual quantities and actual costs. Explain cost analysis. Produce an overview on the interface from order management to cost accounting.

  • 16.4 Activity-Based Costing

    Intended learning outcomes: Disclose the limits of traditional product costing. Explain activity-based costing: aim, basic premise, requirements, and technique. Present typical processes (activities) and process variables as well as the activity-based product cost estimation.

  • 16.5 Summary


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